1H20 earnings to fall single-digit due to impact of COVID-19We estimate that revenue at China Communications Services (CCS)fell 0.2% YoY in 1H20 mainly on the impact of COVID-19. We expectnet margin to remain flat and net profit to fall 3.5% YoY toRmb1.65bn due to construction of emergency communicationnetworks, which generated higher input during the pandemic.Staffing costs are rigid when the topline faces pressure.
Trends to watch
Construction lags due to COVID-19 to hurt 1Q20 topline. During the1Q20, TIS businesses (incl. onsite construction) were halted for trafficcontrol, thus delaying carrier biddings. We expect work resumption in2Q20 to have partly mitigated the impact of COVID-19. As carriersstarted accelerating 5G construction from 2H20, we think CCS willcatch up with demand from carrier clients and retrieve delayedorders, while revenue recognition will be confirmed upon completionof construction.
Margin facing pressure for rigid staffing cost and one-off pandemicexpenses. We expect CCS to continue facing pressure from carriers tocut prices, as 5G construction scales up, and carriers face rising capexand expenses. We also expect staffing costs and other expenses toincrease, as CCS accepted emergency tasks on telecom infrastructurein COVID-19 affected areas. We believe margin will slip in 1H20.
Demand to pick up in 2H20. Excluding the impact of the pandemic,we expect CCS to benefit from accelerated ramp-up 5G networkconstruction at carriers in 2H20. In longer term, we expect CCS toincrease its portion of carrier investment (incl. network capex, opex,and comprehensive software solutions). New infrastructure policyshould stimulate additional downstream demand from smart city andinternet data centers (IDC) which should drive up the non-carrierbusiness at CCS. We expect revenue at CCS to grow at a single-digit infull-year 2020, a little slower than net profit improvement.
Valuation and recommendation
We trim our 2020 and 2021 revenue forecasts 3.6% and 3.9%, andcut our 2020e net profit forecast 3.9%, given pricing pressure fromcarriers and COVID-19 impact this year. We raise 2021 net profitforecast 1.5%, as we expect ramping up non-carrier business wouldhelp to improve margin. The stock trades at 9.8x 2020E P/E. Wemaintain OUTPERFORM and our TP of HK$6.50 (12.4x 2020 P/E),offering 29.5% upside.
Risks
Price pressure from carries clients; uncertainty in non-carrierbusiness initiatives.